Smart City Development Holdings (HKG:8268) Might Be Having Difficulty Using Its Capital Effectively

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Smart City Development Holdings (HKG:8268), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Smart City Development Holdings, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.031 = HK$3.4m ÷ (HK$390m - HK$283m) (Based on the trailing twelve months to March 2021).

Thus, Smart City Development Holdings has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Construction industry average of 7.4%.

See our latest analysis for Smart City Development Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Smart City Development Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Smart City Development Holdings' ROCE Trending?

When we looked at the ROCE trend at Smart City Development Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.1% from 29% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Smart City Development Holdings has decreased its current liabilities to 73% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Smart City Development Holdings' ROCE

In summary, Smart City Development Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 66% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Smart City Development Holdings does have some risks, we noticed 4 warning signs (and 1 which shouldn't be ignored) we think you should know about.

While Smart City Development Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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